Fund Facts present that “empty ta da” moment!

As usual, when faced with insanity there are always a number of competing depictions of the moment’s apogee: I had thought of “the lowest common denominator and the killer of fools”, “wake up and smell the commission”, but that ““empty ta da” moment” won through.   Yes, Fund Facts comes straight from the magic box of procrastination and irrelevance to create a sleight of hand that passes the muster of the hear no, see no and speak no evil crowd.

Tell a Canadian that their financial advisor is merely a salesperson, and that they cannot rely on their verbal assurances, that they alone are responsible for the investment decision, and you will be met with the type of look reserved for doggy poo on the bottom of your shoes.   Try getting anyone in a position of influence to hammer home that fact, and well, its like asking them to tell the emperor he has no clothes.   People neither want to hear nor to tell the truth. 

So when we hear phrases uttered by the mutual fund distribution system about the new mutual fund point of sale “The answer to every advisor’s prayer … a compliant one-stop solution for fund info.” we know that the sales people at least kind of get it.  And please note, that I have piggy backed again on a recent Jonathan Chevreau blog article – Fund Facts — The answer to every advisor’s prayer-

Please note: these documents are meant to bind the investor to the investment decision.  They are “supposed” to hold all the relevant information needed for the investor to assess whether the fund meets their risk profile, their time horizon and their investment objectives.   You can in fact connect the dots between the KYC and the Fund Facts document, because that is all this exercise is: this ties the information provided by the investor (KYC) to the product and confirms the investor’s decision to buy the fund.   The advisor moves outside the loop.  It is disarmingly simple,  and if I were a distributor I would be secretly rubbing my hands in glee, for we have effectively, moved from a loosely regulated transaction industry to one where there are no loose ends and no doubt as to who is responsible.  The regulators have deemed that the information in the FF is sufficient to make an informed decision, and written at a level where everyone can validly lay claim to their decision.

The Fund Facts is a crazily simple, “join the dots”, “tie the knot”, “ta da”, “fait accompli” moment that will formally and finally confirm Canada’s absurdly low regulatory standards for advisory based retail financial services.   This cannot be what we have been waiting for since at least 1999: why not just bring back the lions and the amphitheatre?  We would get the point.  

Is there enough information in the Fund Fact document to allow an investor to make an informed decision?  Not in any reality, no.    

What does the fund invest in?   Try and find information about investment style, risk and asset allocation differences relative to their benchmark.  Try and find anything of substance that will give you some guidance as to why you need an actively managed fund and you will come up with well, rien!  

Take the Investors Group “Investors Dividend Fund – Series A”: it states that it aims to provide above average income yield.  What!  With an MER of 2.69% this is both mendatious and misleading!  What is the actual current yield?    Well, if we look at the March 2011 annual report, annual income was some 3.75% of the investments as of 31 March.  Net income after all deductions was some 1.34%: hardly an above average income yield, but then again no claim as to the comparison.

Top 10 Investments – if you are going to make an informed decision, and you are taking responsibility, you need the distribution of the entire portfolio, its sector, market cap, yield, risk and price relatives to ascertain its exact position in the firmament and not just the top 10.   But hey! It looks good, and if you do not have a clue as to how to research an investment, or where it may fit in your portfolio, it may even yield an aura of substance. 

How has the fund performed? – there is no risk of the client finding out where the fund stands relative to others as well as to its comparative benchmarks.   So there is no choice and no panorama for an informed decision, merely a scrambling around in a dark and nebulous region.   Enlightenment is not the objective of the Fund Facts: do not look here for any form of financial renaissance.

How risky is it?  There is a range of risk from low, low to medium, medium to high and finally high but no framework or benchmark in which to place these benign captions.  Risk is a multi faceted character and there is really nothing here that the investor can use to  verify and quantify the risk of the fund, let alone the risk of the fund within their portfolio.   Again with reference to the Investors Dividend Fund, the fund is 80% equities and yet is placed in a low to medium risk compartment: the Morningstar report on the fund states that its risk is high relative to its category and its performance low.  Quite frankly I do not know what they mean by low to medium risk: if I was wholly exposed to this fund I would have thought I would be exposed to quite a lot of risk, would’nt you?  In which realm do the risk categories reside?  

The warnings in this section seem wide, general and vague: I looked at another fund, the Imaxx US Equity fund, which had returned 0.11% per annum since 2002, which invests in US growth stocks.  The warning was “do not buy this fund if you have a low tolerance for risk and want to preserve capital”: I would have thought that this warning would apply to practically every equity fund, and not just this equity fund.

Who is this fund for?  Here we are: the cover your backside moment! 

“Before you invest in any Fund, you should consider how it would work with your other
investments and your tolerance for risk.”

Surely not the investor?  Is this not the advisor’s job?  No it is not, at least under current regulation, even if your advisor makes it look as if they are personally recommending this as a damn good investment.   You the investor are making the decision, so you better be damn sure you are getting what you are paying for and that there will be minimal surprises.   What this really means is that you need to get off your backside and drill deeper into the fund and how it fits with your other assets, so good luck getting all the information you need.

Sales charges and expenses – it is interesting that for some fund facts, the sales charge option has already been decided by the time the FF is delivered – others do provide a range of costs and options.  The FF also only frames costs in terms of the capital and not the return.  An annual MER of 3% of capital may not sound large, that is until you frame it as a % of historic average return, and then you are talkin’.   If we do not frame costs in terms of impact on return over time, then we are really not providing any insight at all.

Fund expenses – not paid directly: course they are, just not direct from your wallet or bank account, but direct from your investment capital. 

Trailing commission – pays for services rendered?   The FF does not explicitly state what these services are, let us hope your advisor does!

There is not enough info to make an informed decision, only sufficient to link the recommendation to the KYC.   Of course, a separate sheet with much more detailed information on risk, asset allocation style, historical risk and asset allocation (detailed sector, market cap, P/E, P/B, yield relatives) and performance to a number of relevant benchmarks needs to be provided.  Not that I think many investors would be able to make head nor tail of the data and the stats, but it would provide the type of information that a small number of investors could use to accurately assess the efficiency and relevance of the recommendation.  We would still be left with the majority of investors who in reality do depend on their advisor to act knowledgeably and proficiently in their best interests, and for whom the current system cares not whether they serve that need or not.  To be exact, as stated in my previous post on the subject, Banking on our lack of financial savvy, advisors do not have to act in your best interests.

As it stands, under regulation of minimum standards in the retail advisory segment, investors are fair game and the new FFs codifies this state of affairs.  Shameless really, but not enough who know better actually care and not enough who could force change have the integrity and sense of justice needed to take to take this ball to hand.    

I wrote a detailed report into Canadian regulation and the new Point of Sale documentation with international comparisons in September of 2010.  If you really want to get into the nitty gritty (are you insane?), once you start looking at the detail and structure of financial services and their regulation it can get very dense, then read this document: Point of Sale Disclosure and Regulatory Failure in Canada

Beware of Falling Masonry–a comment on today’s Economist’s article…

Beware of falling masonry, an Economist article neatly summarises some of the critical aspects of the Euro crisis: the encroachment of the crisis on the Euro core; the net foreign liabilities of the weaker Euro members; the exposed position of Euro banks dependent on wholesale credit markets; the gathering run on banks by both retail and institutional investors; deleveraging by the Euro financial system; the impact on emerging market borrowers of financial system retrenchment; fiscal austerity and near certain recession, and the compounded risks of them all.  

Where it may be unwittingly over optimistic is the belief that ECB buying of Euro debt could avert disaster.  Unfortunately the disaster is a real economic, at heart, and not a monetary phenomenon, and monetary support can only provide time, if applied early, which it has not.  There is also reason to suppose that monetisation in an overarching excessive debt environment may create mismatches between supply and real demand, that could exacerbate and accentuate financial system risks: note the large increase in inventories in the US that may have been occasioned by confidence created by rising asset prices due to central bank debt monetisation.   

The idea of a “European Redemption Pact” is also naive in the sense that transferring debt to a vehicle to be paid off over a 25 year period ignores one important reality: repayment of debt impacts the GDP base, preventing an economy from growing and forever exposing it to economic risk.   Forcing the Eurozone to repay debt (as opposed to merely refinancing) will forever impinge on the growth of the Eurozone. 

The only way debt can be made manageable is to either default or to allow nominal GDP growth to reduce the burden of debt.  But, once you move beyond the point where you can no longer reduce expenditure and finance your own deficits, without serious and adverse consequences, you no longer have the option of letting nominal GDP growth lessen your burden. 

In many economies nominal GDP growth is in the mid to single digits, but debt financing costs and/or budget deficits prevent nominal GDP growth from reducing debt to GDP ratios.  

The Price of Burgers in New York

I would like to comment on a Preet Banerjee article in the Globe and Mail this weekend, that skirted over the issues of house prices and consumer debt in Canada.

“Looking at debt-to-income is only part of the story. You need to see what that debt was spent on. In other words, why do so many analyses ignore the other half of the balance sheet: assets? A lot of that debt is mortgage debt. Housing has done well, so on the asset side, we are doing much better. Our net-worth to-income ratios are higher. “

I beg to differ Preet, most serious analysts are well aware that assets are the other half of the balance sheet. 

If borrowings had been applied to consumer goods we would have had more inflation, a rise in interest rates and an “arrested development” of the debt mountain. 

As it is, we have excess asset focussed money supply growth that has pushed up asset prices.  The relationship between asset prices and the future real growth in output of an economy is important: asset prices need to reflect income and future growth in income; if the present value of these assets exceed the discounted present value of income (or output growth effectively) needed to finance these assets (and to provide future demand for these assets) then asset prices will need to fall; if asset prices fall, and investors cannot finance the debt, they are likely to default, which reduces money supply, tightens credit and impacts economic demand, output and asset values.  It is precisely because debt has been used to push the price of assets above equilibrium values that the risks of debt are so high. 

It is also worth noting, that we only need the marginal investor to default, not the entire nation of homeowners, for the impact on asset prices and hence debt to gain momentum: assets are priced at the marginal transaction.

Secondly, our lending practices are more conservative. We don’t have as many people, proportionately, in over their heads.

If lending practises were more conservative then debt levels would not have reached current levels.  The fact is that much of Canadian GDP growth post 2008 has come from this debt fuelled property boom.   The immediate risks to the Canadian financial system may not be as significant given the differences in underwriting practises, but the risks to the economy are significant and real.  All this debt represents money supply (and hence lending) that has been permanently allocated to one area of the economy: it is a great weight on future growth.

Third, while there may indeed be a drop in housing prices, it may not cascade into a financial system meltdown anywhere near what happened in the U.S. If you have 50 per cent equity in your house and the price drops 30 per cent, you get angry but you don’t necessarily default on payments. The sub-prime mortgage market in Canada is virtually non-existent. Anyone with a mortgage balance outstanding close to the value of their home is also required to have mortgage default insurance.

Again, it is the marginal debt holder and the marginal default that leads the way, and it is the debt accumulated in the last few years as prices have risen that will impact the economy.  These homeowners do not have the luxury of 50% equity.  Also, many homeowners have taken out home equity lines of credit taken on their homes, some of which will have been used to fund expenditure: if the economy moves into a recession, consumers may well default on their obligations to their lines of credit.  

So, while we could very well see housing price declines, the conclusion that it would lead to something more grave may not be warranted.

Canada has boomed (in relative, though not absolute terms) over the last few years, but it is a marginal economy highly dependent on commodities, financials and for the last few years a debt fuelled housing boom.   I am sure we cannot rely on housing for growth and stability, and with the long term outlook on financials also surely weak in terms of GDP contribution, it is a worry that the bedrock of Canadian growth appears dependent on the marginal growth of the commodity hungry developing and emerging markets.  

The level of debt that has built up in Canada is a concern.

Counter take – The Ebb and Flow of Finances featured on the

Comments on The Ebb and Flow of Finances 

A five year rule is no more than a rule of thumb and a dangerous one if inappropriately used: it comes from a general assumption that holding equities over a five year period will allow one to recover declines caused by recessions and or other significant economic risks.  

I remember analysing the time frame of these risks back in the late 1980s and I would agree, that a five year rule is a vaguely reasonable (fuzzy) benchmark under normal conditions (a period of long term growth interspersed with recessions brought about, inter alia, by “normal events” such as monetary tightening due to short term excess demand as the business cycle matures and frays round the edges).

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Current environment and to hedge or not to hedge part 2

This follows a thread at Jonathan Chevreau’s Findependence Daysite.

Yes I am highly liquid at the moment.

Market valuations in many markets are not expensive by historical benchmarks, but are not cheap in the context of the present environment.

With regards to valuations, I just do not think that a trailing P/E ratio of, for example, below 10 today is the same as a P/E ratio of below 10 in the early 1980s, or the early to late 1990s. That does not mean that a P/E of less than 10 cannot provide a competitive return relative to bonds, just that it will not provide the type of return you would normally associate with a P/E of 10.

Likewise just because equities yield much more than bonds does not imply that equities are a raging buy: low bond yields at the moment imply tremendous risk and uncertainty over future equity returns.

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Current environment and to hedge or not to hedge part 1

This follows a thread at Jonathan Chevreau’s Findependence Daysite.

A good question.

Current environment: even if we did not have the sovereign debt default risks, US debt ceiling negotiations and renewed and attendant capital adequacy risks of the banking system, especially the European banking system, the vast amounts of private, public and corporate debt in the system and the need for significant structural rebalancing between consumption and production, globally, we would be looking at growth of between 1% and 2% below historical averages for the next 5 to 7 year, and possibly longer. In other words, real economic growth of between 0.5% and 1.5% for the major developed economies: add dividends and inflation and you would have your nominal total equity return before transaction costs and taxes.

This would have been my upper boundary: the lower boundary outcomes could quite easily involve another severe recession involving a GDP decline of 3% to 5%, and this would not be an extreme expectation.

Once we get to the negative scenario (GDP decline of 3% to 5%), we would probably be in another accelerated debt default scenario (public and private most definitely many financial companies) and what happens once you end up there is anyone’s guess. Human beings are not very good at dealing with such situations.

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Sideways market can bring decent returns”$£%*!()_+???

The following is a counter take on a Rob Carrick of the Globe and Mail article “Sideways market can bring decent returns”.


The point being made about sideways markets is, I assume, that they present valuable opportunities to trade the highs and lows and to reinvest dividends.  But this assumes a number of factors: Continue reading

Sideways markets

A comment on The Wealthy Boomer blog 13 September 2011

It would be great if we could believe that we are about to enter a sideways market, but that would suggest an inertia (forces need to be counterbalancing) that I do not think is in the tea leaves.

I am not so sure about sideways markets… I feel that the dynamics of current global economic and financial imbalances suggest a much more rapid denoument. It is all about weight, momentum and support: the weight of debt and the pace at which the problem is intensifying is exceeding the ability to support it…

Japan is an object lesson in sideways market movements (at least post its major plunge from circa 40,000 to below 20,000), but most of that movement occured during a period in which public sector debt was accumulating but had yet to reach a tipping point. Japan was alone at this time and was able to export to hungry western markets – there was a strong counterbalance in this case.

I think we are more likjely to get a major financial and economic rupture, followed by a period of relatively strong growth and a period of above average market returns, albeit from a smaller base. I am not so sure that everyone should be playing the market, this is still subject to immutable mathematical laws.

In behavioural economist terms, a belief in the ability to market time is a belief in the law of small numbers (this means basing a general rule on a small sample that is not representative of the physical dynamics of the larger whole). An individual may be successful, but certainly not the majority.

I also think that many of the sharp moves we are seeing have been caused by people/institutions playing this market and the boundaries of these moves do not represent in any shape or form areas that can be played with any degree of comfort.